Janus Henderson Investors
March 01, 2018
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Lifting the Rock on Cryptocurrencies

Lifting the Rock on Cryptocurrencies | Janus Henderson Blog

Key Takeaways

  • Cryptocurrency-related activities account for a small portion of the overall semiconductor market’s sales, but for some companies, the exposure is significant – and potentially growing
  • The ravenous appetite for computing power has spiked demand for sophisticated chips known as graphics processing units (GPU), but we believe this growth is unsustainable
  • Another potential headwind is the possibility that new technology will be used in mining. This has already been seen in Bitcoin mining as GPUs have been are swapped for newer technology

Bitcoin, Ethereum and Ripple. These represent just a handful of the nearly 1,500 cryptocurrencies now taking markets by storm. As the industry has exploded, so has the amount of computing power required to manage the virtual tender. This need, in turn, is giving the semiconductor industry a boost. But can it last? Research Analyst Jon Bathgate shares his perspective.

Already, some cryptocurrencies have experienced wild fluctuations in valuation, and the arcane industry lacks regulation. True, cryptocurrency-related activities make up a small portion of the overall semiconductor market’s sales, but for some companies, the exposure is significant – and potentially growing.

Cryptocurrency: The Mechanics

Cryptocurrencies employ cryptography to secure transactions, control the creation of additional coins or units and verify the transfer of an asset. And it is not associated with a specific government or country, nor issued by a central authority. Instead, it exists on a peer-to-peer network, with transactions recorded in an immutable public ledger known as the blockchain.
Making up the network are so-called cryptocurrency miners. Anyone with access to the Internet and the right hardware can be a miner, whose ultimate goal is to verify transactions (or blocks) by solving complex math problems. The first miner within the network to solve one of these problems gets to add a block to the “chain” (creating the blockchain). For the effort, the miner receives a “reward” in the form of a transaction fee and/or new coin.

Most cryptocurrencies have a finite supply. When Bitcoin, the most well-known cryptocurrency, was launched in 2009, the market was established with a limit of 21 million units and a set number of bitcoins that could be mined at any one time. As a result, Bitcoin’s algorithms have become increasingly complex, requiring exponentially more computing power. Less than a decade ago, a typical home PC could mine a single bitcoin in about one or two days. Today, the task would take the same PC more than 100 years to complete.

The Impact on Semiconductors

This voracious appetite for computing power has spiked demand for sophisticated chips known as graphics processing units (GPU), which historically have been used in gaming applications. In turn, semiconductor firms that specialize in GPUs, such as Advanced Micro Devices (AMD) and Nvidia, are struggling to provide sufficient supply, pushing up prices. At first blush, this may seem like a positive development. AMD’s revenue climbed 25% year over year during the most recent quarter, while Nvidia reported record revenue of $2.64 billion, a rise of 32%.

However, we think this growth is likely unsustainable, as wild fluctuations in cryptocurrency valuations could cause demand for GPUs to quickly falter. One bitcoin was worth less than $1,000 at the start of 2017. By December, the value climbed to more than $19,000, before dropping by roughly 40% this year. Falling cryptocurrency values could weigh on the profitability of mining, hurting demand for GPUs.

Another potential headwind is the possibility that new technology will be used in mining. A few years ago, Bitcoin miners, hungry for more computing power, began swapping GPUs for application-specific integration circuits (ASIC), chips that are customized for a specific use and therefore more efficient at a singular task (in this case, mining bitcoin). As a result, demand for GPUs cratered. Something similar could happen with the hundreds of other currencies now being mined, potentially weighing on GPU pricing.

Keep in mind, we estimate that cryptocurrency-related activities account for just 1% of total semiconductor market sales, and some segments, such as memory, have very little exposure to the trend. Moreover, long-term sustainable growth could be achieved as blockchain is used in other applications, such as speeding up and simplifying transactions in the financials industry or improving data management in health care. But in the near term, investors may want to do their own digging to understand their exposure to cryptocurrency – and brace for potential volatility.

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The value of cryptocurrencies is highly volatile and considered speculative. Their growth and networks are highly uncertain. There is no assurance they will continue in existence or grow. A decline in the popularity or acceptance may negatively impact their value.

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